Making Income-Based Repayment of Student Loans Cost-Effective

Concerns about the rising cost of college and mounting student-debt loads, as well as political pressures during the ever-constant election season, recently led Congress and the Obama administration to relax income-based repayment requirements for student loans. While students now have to pay 15 percent of their discretionary income for 25 years before any remaining balance is forgiven, soon they will have to pay only 10 percent for 20 years under the new system.

The New America Foundation has just released a much-commented-on analysis explaining that changes in the income-based repayment program will primarily benefit high-income individuals with large amounts of debt. That’s one big problem—which will probably reduce the cost-effectiveness of the program.

There’s another problem. The changes may undercut the administration’s efforts to encourage high-priced colleges to lower the cost of attending their institutions.

Rhetoric about the $1-trillion in debt held by student borrowers today omits a key point: Most undergraduates end up with debts they can manage. An analysis by Mark Kantrowitz found that those who earned bachelor’s degrees in 2011 graduated owing about $27,000. As Kantrowitz pointed out, that’s roughly the cost of a new car. Studying data from 2007-8, he found that only 1.5 percent of undergraduate and graduate students hold the six-figure debt burdens we hear so much about. Most (90 percent) of those attended graduate or professional schools. Most of the undergraduates were likely to have attended expensive colleges that cost more than $30,000.

What happens when we allow all students to reduce their debt? In 1987, then-Secretary of Education William J. Bennett argued that federal loan subsidies were enabling “greedy colleges” to raise tuition. He was at least partly right: At best, the changes in the student-loan program will create no additional incentive for institutions to contain costs; at worst, they may even provide an incentive for them to raise prices. We could be facing a perfect storm, since many Americans falsely conflate the cost of a college with quality. Seeking a “better” education, and knowing that they will probably not have to repay the full amount, they may borrow even more.

While it’s possible—though not likely—that a substantially more expensive college is worth substantially greater debt, the bigger issue is that in the long term, lowering student debt for all students drives up costs in the marketplace. It also perpetuates a continual shift of the costs of higher education onto the backs of students and families, rather than forcing colleges and universities to find ways to operate more efficiently.And, significantly, it disadvantages the many students and families who are unwilling or unable to access large amounts of loans.

If the housing debacle has taught us anything, it’s that easy access to cheap credit can have adverse consequences. Just as the price of housing became unaffordable for many people during the housing-market bubble, so the cost of higher education will continue to skyrocket and be out of reach for many Americans.

Discounting loan repayment for students who elect the most expensive educations and who may earn the highest incomes not only encourages bad behavior by both students and colleges, it may also minimize the student-loan program’s impact on stimulating the economy and promoting growth in human capital. Numerous studies suggest the obvious: The most price-sensitive individuals are those with the lowest incomes. But the changes in the income-based loan program will disproportionately benefit wealthy students (and those who will in the future become wealthy) at selective colleges (as opposed to community colleges or regional state universities)—those students who need the least incentive to attend college.

Now, some proponents of the changes may argue that they will give incentives to wealthy students to spend rather than scrimp, thus stimulating the economy. And no doubt, others will applaud efforts to encourage more students to pay more for higher education, telling them that “quality” will pay off. Perhaps the higher-education lobbies have supported the repayment changes for that reason. Helping students to pay more for college puts additional money into college coffers, but it isn’t a cost-effective investment.

Instead, we suggest:

Apply the 10-percent rate only to the first $75,000 of household income per year, with a 15-percent rate on additional income.

Apply any liberalized repayment rules only to undergraduate loans and (past) subsidized graduate loans. The federal government should focus help on getting more students through at least some postsecondary education instead of subsidizing doctors and lawyers. Those do-gooders who pursue a graduate degree to make a difference in the world are still eligible to have their loans forgiven for public service—and this way, they’ll continue to have a nudge to embrace that service.

Consider limiting eligibility for income-based loan repayment to students who attend expensive colleges of any kind. Those students do not receive larger Pell Grants, and they should not receive more loan repayment assistance than someone who chooses a less expensive college. If we’re worried about whether institutions will maintain a commitment to economic diversity, let’s keep an eye on that commitment. In the meantime, let’s encourage colleges to lower costs.

Income-based repayment programs have the potential to help students pursue postsecondary education while worrying less about debt. That is a commendable goal, and it should be achieved in as cost-effective a manner as possible in order to preserve resources for other postsecondary education priorities.

Sara Goldrick-Rab is an associate professor of educational-policy studies and sociology at the University of Wisconsin at Madison. Robert J. Kelchen is a doctoral candidate in the university’s department of educational-policy studies.